Recession not expected, says IMF; Analysts say stagflation risk is strong: What is the difference?

The International Monetary Fund (IMF) chief has forecast a tough year for the world. Rising food and fuel costs partly due to the war in Ukraine, compounded by Covid-19, high interest rates, inflation, strengthening dollar, are some of the complications the world will have to endure. The fears now are - could recession add to the troubles?

Speaking at the World Economic Forum, IMF chief Kristalina Georgieva said that recession is not on the cards but “it doesn’t mean it is out of the question”.

Most central banks around the world have started raising rates to control inflation, their challenge is to negotiate a “soft landing” which means to raise rates just enough to cool inflation without pushing the country into recession.

What is recession?

Recession is a sustained period of low economic activity and starts when an economy is at its peak and ends when it reaches the trough. The rule of thumb to call inflation is when the Gross Domestic Product (GDP) shrinks for two consecutive quarters. There may be an intervening period of growth before it turns negative again. Not just GDP, but other economic indicators like employment, real income, sales, and industrial production etc are also used to determine contraction.

Recession is usually the outcome of tightening monetary policy to control inflation or when companies and individuals overleverage (borrow more than they can repay) and are forced to divert spending to fulfil their obligations.

What is stagflation?

Stagflation becomes a fear when inflation is high in a period of slow economic growth and unemployment. Now, in normal circumstances inflation and economic stagnation do not accompany each other. But stagflation became a reality in the 1970s when there was a general rise in inflation because oil prices had shot up due toi an embargo, and at the same time since input costs rose, companies produced less and hired fewer people – there was high unemployment.

Economists world over are concerned that stagflation may be back, especially in the high income countries. That is because inflation is being driven again due to supply side issues (Covid and war-related blockades) and high liquidity in the system (Covid aid packages), not because economic activity was at its peak per se. Although high demand and low supply in the wake of lifting lockdowns did in part contribute to inflation as well.

The inflation is hurting household expenditures, and people have less disposable income and so they are cutting back on spending as their food and energy bill rises. High fuel rates is driving up transportation costs, which is having a cascading effect on other items as well.

Meanwhile, some countries in Europe for example have reported low economic activity in the first three months of this year because of the war in Ukraine. Supply disruption and high energy costs resulted in lower production, contracting the GDP.

The US too is witnessing slowing growth but interestingly unemployment there is at an all-time low, so analysts say that noticing stagflation may not be easy.

Controlling stagflation in the current situation is challenging because hiking rates will make growth take a backseat while lowering rates will push up inflation. However, we will only know whether a recession or stagflation is upon us after considering data over a few months, not at one point.

The IMF had earlier said in a statement that the economic damages due to the war in Ukraine will contribute to a significant global slowdown in growth in 2022 and 2023 and add to inflation. IMF predicted that global growth is projected to slow from an estimated 6.1 per cent in 2021 to 3.6 per cent in 2022 and 2023.